Definition of Capital Instruments
Capital instruments are financial tools that companies use to raise capital. They encompass a range of instruments such as:
- Shares: Equity stakes in a company, representing ownership and entitling shareholders to a portion of the company’s profits.
- Debentures: A type of debt instrument not secured by physical assets or collateral. Debentures are backed only by the general creditworthiness and reputation of the issuer.
- Loans: Borrowed money that the company must repay with interest.
- Options and Warrants: Financial derivatives giving the holder the right, but not the obligation, to buy or sell a security at a predefined price before or at the expiration date.
In accounting, it is crucial to understand the distinction between capital instruments and equity. The current regulations governing these distinctions are contained in Sections 11 and 12 of the Financial Reporting Standard Applicable in the UK and Republic of Ireland, as well as International Accounting Standard (IAS) 39 for listed companies.
Examples of Capital Instruments
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Shares:
- Common Shares: Give owners voting rights but rank below preferred shares in dividend payments.
- Preferred Shares: Typically do not confer voting rights but have a higher claim on assets and earnings than common shares.
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Debentures:
- Convertible Debentures: These can be converted into equity shares after a specified period.
- Non-Convertible Debentures: These cannot be converted into shares but might offer a higher rate of interest.
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Loans:
- Term Loans: Loans that are provided for specific terms and repaid over time.
- Revolving Credit Loans: A line of credit where the borrower can draw, repay, and redraw loans.
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Options and Warrants:
- Call Options: Give the holder the right to buy a stock at a specific price.
- Warrants: Long-term options issued by companies allowing the holder to buy the company’s stock at a particular price.
Frequently Asked Questions
Q: What is the main difference between shares and debentures? A: Shares represent ownership in a company and entitle shareholders to dividends and voting rights. Debentures are a form of debt and do not confer ownership but oblige the company to repay the principal amount with interest.
Q: How do options and warrants differ? A: Options are typically traded on exchanges and have shorter durations, while warrants are issued by companies directly and tend to have longer durations.
Q: What regulations govern the classification of capital instruments? A: The classification of capital instruments is governed by the Financial Reporting Standard Applicable in the UK and Republic of Ireland (Sections 11 and 12) and International Accounting Standard (IAS) 39.
Q: Can loans be considered capital instruments? A: Yes, loans are considered capital instruments as they are a primary means for a company to raise finance.
Related Terms with Definitions
- Equity: The residual interest in the assets of the entity after deducting liabilities. Equity equals ownership.
- Convertible Securities: A category of securities that includes convertible bonds and convertible preferred shares, which can be converted into common shares.
Online References
- Investopedia: Types of Capital Instruments
- International Financial Reporting Standards (IFRS): IAS 39 - Financial Instruments: Recognition and Measurement
Suggested Books for Further Studies
- “Financial Accounting and Reporting” by Barry Elliott and Jamie Elliott
- “International Financial Reporting: A Practical Guide” by Alan Melville
- “Principles of Corporate Finance” by Richard A. Brealey, Stewart C. Myers, and Franklin Allen
